Company Profile - Wesfarmers Limited is engaged in retailing operations, including supermarkets, general merchandise and specialty department stores; fuel, liquor and convenience outlets; retailing of home improvement and outdoor living products and supply of building materials; retailing of office and technology products; coal mining and production; gas processing and distribution; insurance; industrial and safety product distribution; chemicals and fertilizers manufacture, and investments. The Company operates in four segments: Retail, Insurance, Industrial and Other. The Retail segment includes Coles, Home Improvement and Office Supplies, Target and Kmart. Insurance segment includes supplier of specialist rural and small business regional insurance; supplier of general insurance through broking intermediaries; and supplier of insurance broking services. Industrial segment includes resources; chemicals, energy and fertilizers, and industrial and safety.

Analysis - Capital management is likely to increase in 2014 resulting in increasing yield support and defensive characteristics of the WES share price. There is likely to be moderate negative effect on earnings from slowing sales revenue growth at Coles. Coles appears to be finding it increasingly challenging to cycle four years of above industry growth, constraints of fuel discounting and a slowing of the cost efficiency benefits to fund additional promotional expenditure. There is a moderate downside risk that the effect of oversupply in the WA Ammonium Nitrate market will be pulled forward into the CY2014. We believe that the resources earnings will bottom in Fy2014 and the earning from Bunnings will continue to accelerate.
The likelihood of downwards pressure on earnings from the chemicals division increases in CY2014. It is feasible that Wesfarmers will increase the length of contracts to lock in its plant utilisation ahead of the commissioning of Burrup. Therefore the earnings effect of Ammonium Nitrate competition in Western Australia may become visible well ahead of the physical opening of the Burrup plant.

Capital management is likely to increase in 2014 and beyond due to the benefits of slowing investment, business divestment and net property divestment. In the first half of 2014 WES distributed $0.50 per share via a capital return and share consolidation. The capital return distributed the proceeds of property sales complete in 2H2013 and 1H2014. Through the course of calendar 2014, WES is likely to distribute additional $1.6 B net proceeds after payment of tax on profit on sale of the recently announced sale of the Insurance underwriting and the more moderate $70 Million in net proceeds from the sale of its interest in Air Liquide Australia. Holdings of freehold land and buildings are likely to have peaked in June 2013. From FY14 to FY16, disposals are likely to exceed acquisitions of freehold property.

It is likely that in Fy14 revenue growth at Coles will more closely match that of Woolworths Australian Food and Liquor due to the increasingly challenging high base created by four years of outperformance by Coles, new constraints on fuel promotion that came into effect on 1^st January 2014 and a declining rate of large cost out opportunities to support increasing levels of promotion.

An agreement with ACCC   toe cap fuel discounts at 4c per litre from 1 January 2014 is likely to be more impactful on Coles rather than Woolworths. Fuel discount vouchers have been an important tool by Coles to increase the size of shopping baskets and the financial impact has been lower on Coles than Woolworths due to a lower redemption rate of paper based vouchers versus the Woolworths loyalty card.

Industry profitability is likely to improve in 2H14 due to lower expenditure on fuel promotions. It is likely that it would take some time for competitive intensity in other forms of promotion to reach the same heights that existed in fuel promotion during 2013.

An improvement in efficiency over the past five years has helped to fund the improved market positioning of Coles.  Labour units have fallen 20% relative to volume, waste has halved as a proportion of sales and supply chain cost per carton has fallen. The absence of a large cost reduction opportunities translates into less opportunity for funding  a higher level of promotion. The net space growth will become a more important determinant  of sales growth and the incremental profit from sales generated by space growth is lower than that generated by growth in same store sales.



Source – Company Reports

Price		Price % Change
Close:	41.32 (05-Feb-2014)	3M:	(4.13%)
52 Wk High:	44.60 (25-Nov-2013)	6M:	0.54%
52 Wk Low:	36.76 (13-Jun-2013)	1Y:	8.55%

 

WES (AUD, Millions)	2013	2012	2011	2010	2009
Total Revenue	59,832	58,080	54,875	51,827	50,982
Gross Profit	19,805	19,279	17,998	17,074	16,906
Total Operating Expense	56,606	55,036	52,169	49,612	48,986
Operating Income	3,226	3,044	2,706	2,215	1,996
Net Income Before Taxes	3,226	3,044	2,706	2,215	1,996
Provision for Income Taxes	965	918	784	650	474
Net Income After Taxes	2,261	2,126	1,922	1,565	1,522

 
 
The Chemical, Energy and Fertiliser division primarily consists of three parts – chemicals (largely Explosive Grade Ammonium Nitrate to the mining industry), Fertiliser ( largely distribution of ammonium based fertilisers) and Energy ( LPG production and distribution). There is broad consensus that the WA Ammonium Nitrate market will be in over supply post commissioning of the Burrup AN plant from 2016. It should also be noted that the South East Asian, market is undersupplied by up to 300,000 tonnes. Indonesia and Various other south east Asian markets and even Australia import Ammonium Nitrate from china, Ukraine, Russia, France and the US amongst others.
The likely response to the upcoming commissioning of Burrup would be for WES to attempt to increase the length of contracts to extend its period of incumbency. The effect would be to bring forward the earnings impact of excess supply but perhaps smooth the impact once Burrup is commissioned. Under that scenario, it would be likely that downside pressure on earnings would become evident in CY 2014.
We believe that there might be a bottoming of the hard coking coal price in FY 14. A drop in cash costs to around $75 a tonne occurred in FY13 due to the cycling of wet weather impacted production from FY12 and a steep down in costs due to contract negotiation. Inclusive of royalties cash breakeven is at $95 a tonne. The coal produced at Curragh, QLD is high quality, and approximately 40% of the production is high grade hard coking coal and the remainder is split between semi hard and PCI. Revenue was $113/tonne in FY13 and is likely to fall to $108/tonne in FY14.Upside to earnings from discretionary retail divisions is likely to be offset by a reduction in earnings from the resources division.

WES	Industry Median	2013	2012	2011	2010	2009
Profitability
Gross Margin	25.0%	33.3%	33.4%	33.0%	33.2%	33.4%
EBITDA Margin	6.9%	7.8%	7.8%	7.5%	7.1%	7.5%
Operating Margin	4.7%	5.4%	5.2%	4.9%	4.3%	3.9%
Earning Power
Pretax ROA	8.8%	7.5%	7.3%	6.8%	5.7%	5.3%
Pretax ROE	22.3%	12.5%	11.9%	10.8%	9.1%	9.1%
Liquidity
Quick Ratio	0.55	0.58	0.55	0.60	0.64	0.70
Current Ratio	0.90	1.11	1.02	1.17	1.23	1.32

 

Dividend
Yield	4.59832	FY
	4.837796	5yr Av
Payout Ratio	92.12738	FY
	88.06939	5yr Av

 
WES has significant debt and equity capital availability and is therefore financially able to make material acquisitions. Whilst it is highly uncertain to assess the likely share price reaction to any un-specified acquisition, several factors suggest that the upside risks to share price in short term from an acquisition are low. We would be putting a HOLD on WES for subscribers who currently hold the stock.

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